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Join James Connor as he dives deep with Michael Green, Portfolio Manager and Chief Strategist at Simplify Asset Management, into the critical distinctions between passive and active investing and its implications on market signals and the economy. This conversation sheds light on the concerns surrounding the US economy, debt levels, real estate sectors, and the broader global economic landscape. Michael Green offers invaluable insights into how investors can navigate these complex times, emphasizing the importance of understanding the growing influence of passive investing strategies on market dynamics. Discover practical advice for safeguarding your investments and learn why educating yourself on these topics is crucial in today’s financial environment.


James Connor 0:05
Hi and welcome to Wealthion I’m James Connor. People are always asking, should I be fully invested? Should I increase my cash waiting? Should I be more defensive? Or should I take a more aggressive stance? And we try to find people who can help us answer these questions. Today, my guest is Michael Green Portfolio Manager and chief strategist at simplify asset management. And Mike is going to help us answer some of these questions. Mike, thank you very much for joining us today. You are not in your office. Where are you?

Michael Green 0:33
I’m actually just outside Cortland, New York in my self driving vehicle, so we should be totally fine. Don’t worry about it. If, if you see evasive action, it’s got the robot has it under control.

James Connor 0:46
That’s great. That’s great. And I hope you have a coffee like Are y’all relaxed?

Michael Green 0:51
Oh yeah, I’ve got coffee And a podcast and a car so I should be in good shape.

James Connor 0:55
Mike, before we do the deep dive on the economy, I want to first ask you a question that I like to ask all my guests and and whether or not if there’s anything that concerns you? Or is there anything that keeps you up at night? And that could have something to do with politics, the economy or the global economy?

Michael Green 1:12
Well, I mean, I think, unfortunately, all of us that are aging know that we stay up at night, regardless of whether there’s anything to worry about, we find things to worry about, I guess would be the easiest part. The the stuff that I’m really concerned about, unfortunately, is largely around the what I would consider to be the increasingly false signals that we’re receiving from financial markets. In particular, I’m known for the work that I’ve done around the impact of the growth of passive strategies, which are really just simply algorithms that involve anytime you put money into your 401 K or into your IRA through passive vehicles, it becomes a really simple algorithm that simply goes, Did you give me cash? If so, then buy Did you ask for cash? If so, then. So since there’s no thought process that’s going into that, unfortunately, that means we’re robbing the markets of the economic signals that they would have historically provided and changing them from leading indicators to what I would describe as lagging indicators. And so you know, we experienced this firsthand when we went through the COVID dynamics, almost all active managers, anyone who actively followed financial markets was aware of the impending health crisis that was emerging. And yet markets didn’t respond until we literally got to the point that we shut down the global economy. And then they responded in a fantastically negative way, they then responded to the pandemic stimulus in a fantastically positive way. I think we’re at a similar juncture today, where we’re seeing evidence that the economy is weaker than the stock markets would suggest. This manifests itself in a number of ways. But unfortunately, our policymakers, I think, are anesthetized to this dynamic, it leads to the Federal Reserve, being far more concerned about inflation, for example, than it is about the potential risks associated with an increasing refinancing risk associated with commercial real estate, high yield debt, private equity companies, etc.

James Connor 3:13
So you raised some interesting points here, and I want to touch on the passive investing later in our conversation. But you also made mention of the fact that you think the economy is a lot weaker than its than we’re led to believe. And when I look at it, I see the GDP growing at 5%. annualized, the jobless rate is very low. We had a we did have a stronger than expected CPI number recently, and, and just on the back of that the market got hit. And prior to that number, the market was projecting six rate cuts this year, which I find is kind of crazy in itself. But nonetheless, since that CPI number came out now the markets expecting three rate cuts, but maybe you can just tell us what exactly you think of the economy, why you think it’s weaker than we’re led to believe it is. And maybe you can also tell us where you think interest rates are going.

Michael Green 4:04
Sure. So when we’re talking about the strength of the economy, we typically are referring to things like the unemployment rate or jobs, there’s two ways unemployment rates can be low, and unemployment rate can be low, because many people are finding work and there’s lots of opportunity that exists. Unemployment can also be low, because there’s simply not many workers entering the labor force. Unfortunately, we’re facing the second one, much more than we are the prior one. And in fact, if we look at things like full time employment, that’s actually fallen over the last year we’ve had negative job growth in terms of full time employment. we’re increasingly seeing rising unemployment rates for many areas of the market that had benefited and had very strong gains in the past couple of years. Minority employment is is beginning to rise, we’re beginning to see youth unemployment rise fairly significantly. And all of these are creating conditions under which I would suggest that the headline data that we’re receiving is quite a bit more rosy than the actual underlying phenomenon. I think many of your listeners would actually echo that. They’re seeing their own children unable to afford homes that’s caused an incredible explosion of young people that live with their parents, and are increasingly abandoning the idea that they would ever move or get their own home, effectively resigning themselves to what I call the Italian isation of America, where you have a very similar phenomenon in Italy, very small population growth to negative population growth, children live with their parents, the home never gets sold in the public market, it gets passed down as compared to being sold. And as a result, price discovery really doesn’t exist in a place like Italy, you have homes that are very difficult to buy if you want to buy a high end property. But you have an increasingly an increasing number of decrepit properties that you could buy for $1, for example, I think many Americans are actually seeing similar dynamics in their neighborhood, where they themselves can’t afford to maintain their homes, their if they don’t have their children living with them, they really benefit from that component. And you’re seeing just very, you know, what I would describe as changing consumption patterns, and living patterns that are a byproduct of an economy that’s not nearly as strong as the headline would suggest.

James Connor 6:22
Yeah, you raised some interesting points there. First of all, with the jobless number, or with the layoffs that we’re seeing 1000s and 1000s, every major tech companies laying off people, I think, with the exception of Apple, but even Amazon said, they’re going to lay off 20,000 People Google, Facebook also said, every major financial institution is laying off 1000s of people. And so maybe we’re going to see it start seeing more of that in the coming months. But the other interesting point you made mention of is the fact that younger people can’t afford a home anymore. And I think a lot of it just has to do with this inflation number like, you know, the the CPI number that came out just recently, it was a little bit higher than expected. But we know, that’s not the real number, the real numbers probably two or three times that I took my family to Shake Shack recently, and it cost me 80 bucks. And the hamburgers are half the size that they used to be. What are your thoughts on inflation here?

Michael Green 7:16
Well, so I actually ironically, I’m less concerned about inflation. In that context, I’m much more concerned about the inflation that’s being created or the unavailability of housing, the lack of availability of housing that’s been created by the Federal Reserve’s response to the inflation. So hiking interest rates is perceived as contractionary. Right, the idea behind it is that is going to slow economic activity. Unfortunately, that model breaks down under an environment in which you have very high levels of debt. So what we’ve actually done is increased the incomes of those Americans who already have money, who have money sitting in a money market account, or who have money sitting in a bank account, they’re experiencing higher incomes than they would have historically, because of this increase in interest rates. At the same time, those who need to borrow to go out and purchase, ie those who are starting their lives out, are finding that simply unaffordable. And so we’re actually seeing what’s been accurately described as a K shaped economy. Those who are well positioned and have, you know, have cash available to them, are doing extraordinarily well. Those who are struggling and trying to get their first step on the ladder, are finding it increasingly hopeless. And it’s contributing to what I would describe as a nihilistic streak in our economy that we’ve really only seen a few times in the past, one of which, of course, was the 1920s. You know, when you had a similar dynamic, a similar spread in inequality that I think is actually very similar to what we’re experiencing today.

James Connor 8:55
You touched on debt levels, and I guess we have to address the US federal debt level $33 trillion now, and that’s up 50% In the last few years, the debt to GDP is now at 123%. What are your thoughts on this these debt levels? And is it an issue?

Michael Green 9:13
Well, I think it’s definitely an issue, it just becomes a question of, why is it an issue first, a lot of the increases in debt that you’re describing that occurred over the last several years, unfortunately, were just a giveaway. In many situations, right things like the PPP loans, which theoretically allowed, allowed companies to continue to employ people, but effectively just covered costs in an environment in which the economy ended up being much stronger than people had anticipated, and providing a windfall for business owners. The employee retention credit turned into an outright fraud program initially budgeted to cost $55 billion, ultimately costing several 100 billion dollars. You know, those programs that contributed to debt really bought us absolutely nothing except, you know, increasing friction within our society and and, you know, business owners that in many situations were able to take advantage of programs that were disproportionately available to those who could pay lawyers to figure out how to navigate this process. There’s another type of the debt, though that is being you know, that is a byproduct of bringing the off balance sheet liabilities on balance sheet. And it’s unfortunate, because we’ve known that that was coming for a very long time, we’ve heard any number of individuals rail about the unfunded nature of social security, or Medicare, we’re now seeing that come on to the balance sheet. And so that proportion of the debt is actually not something surprising or unusual, and candidly, is something that we should have anticipated? I’m not particularly concerned about that latter portion, right. I am concerned about our inability to effectively tax many segments of our society. In particular, the corporate tax rates, I’ve pointed out to people that NVIDIA, for example, which has just become the world’s third most valuable company, paid almost no taxes over the prior four years. That’s really an extraordinary statement. When you think about the success of a company like Nvidia, I believe their total tax bill over the last four years, until this last year, was only about $87 million in taxes. That just doesn’t seem right. And I think a lot of people are aware of this. And I think they’re they’re understandably frustrated with it.

James Connor 11:32
So I do want to ask you about Nvidia, we, we have to talk about that now. But before we do that, I want to I still want to talk about the economy. And I just want to summarize your thoughts on the US economy, in spite of the fact that the GDP is growing around 5%. annualized, you’re concerned, you don’t think that’s a real number. It’s been propped up by all this fiscal spending? Well,

Michael Green 11:54
I don’t think that number is actually accurate. So the 5% that you’re referring to is a nominal number, right? So that’s combination of inflation. And the real growth rate. If we look at what the real growth rate for GDP was, for 2023, across the entire year, I believe it was around two and a half percent in real terms. That’s above potential when we consider the rate of labor force growth. But it’s not a particularly strong number. At the same time, where that growth is coming from, I think, is actually important as well. And what we’ve seen as we’ve seen an expansion of the government sector, as the private sector continues to grow very slowly and in many situations contract.

James Connor 12:40
Okay, so let’s move on and talk about the equity markets. And of course, a big part of the equity markets now is in Vidya. Nvidia just came out with their numbers here recently in the market took off on the back of that, and here we are trading at or near all time highs on both the s&p and the NASDAQ, as you mentioned, and Vidya is also the third largest market cap in the world now, I think it’s around $2 trillion. The stock itself has gone from 500 to 800 bucks this year alone. So it’s a very important part. What’s your view on the s&p and also the NASDAQ?

Michael Green 13:17
Well, I think when we look at companies like Nvidia, they clearly have come up with products and developed products that not only do they have a unique, effectively a monopoly on, right, they have a unique product that others do not have currently, with the chips that are used for the large language models and what we’re increasingly referring to his AI, right. Because they have that lock, they’re able to charge extraordinary prices, the gross margins that they’re creating off of those products are nearly unprecedented in the hardware space. So I think last quarter, they printed something like a 77% gross margin. Those are levels that are far more consistent with extreme value added services, things like software, for example. And candidly, we’ve just never seen this before. So the results are absolutely extraordinary. The growth rates are extraordinary. Many people have drawn comparisons to cycle, and I think there’s actually a lot of validity to that. We saw similar growth rates for Cisco, or even faster growth rates for companies like JDS unifies that were in specialized areas of the market in that 99 to 2001 time period. This is similar, it’s just it’s gone on longer and is occurring at a scale and a level of profitability that I think surprises many people. At the same time. One of the challenges it’s created is when we look at a company like Nvidia, a sizeable fraction of the shares in Nvidia are owned by passive strategies, which have absolutely no mechanism to critically evaluate the trends, whether these trends are going to continue off into the future, or whether in video like the companies that came before it For the examples I gave, in JDS, unifies and Cisco in cycle, they ultimately overproduced, we saw that inventory written off, there were extraordinary losses. And actually those losses are those those, the decreased prices for those chips, facilitated a lot of the growth that ultimately came afterwards. And networking equipment in the case of Cisco and JDS unifies, facilitated the build out of the telecommunications networks that now allow me to sit in a Starbucks parking lot. I’m not really in a self driving vehicle, and have a communication with you over video, something we couldn’t have imagined 20 years ago, today is very commonplace because of that. I think, you know, one of the challenges is something very similar could happen to an in video where they ultimately, improperly forecast the potential growth of these markets, we end up with tremendous surplus inventory, and write off occurs. Traditionally, the way you would adjust for that is as a discretionary manager, you’d say, yes, it’s an incredible number. Do I think it can be repeated? Do I think the growth of the law of large numbers is ultimately going to reverse itself? And that would manifest itself in falling valuations? We’re simply not seeing an awful lot of that. Right? We’re not seeing markets able to critically evaluate and decide to provide liquidity when these events occur. And it’s not just in video, right? Companies that are being pulled along, they’re not seeing similar fundamental improvement, super micro comes to mind are having similar impacts on smaller end indices, things like the Russell 2000.

James Connor 16:37
Yeah, you mentioned JDSU to face and I totally forgot about that company. Is that company still around?

Michael Green 16:42
It is no, it’s a company that still exists, it’s actually trading under a different ticker. Now, I believe it’s vi a VI, is the ticker. They continue to be a reasonably good networking company that’s operating profitably and selling niche products. It didn’t go away. And I think that’s important for people to understand. And I’m not suggesting that NVIDIA does not deserve the accolades that it’s receiving on a fundamental basis. But to see a stock move in the manner that it’s moving, suggests that something else is at work. And ultimately, I think the real culprit lies in the growth of passive strategies that simply will not sell at any price unless given an external direction to do so.

James Connor 17:22
And so you brought up the fact that it’s very much like the late 1990s or early 2000s. What other similarities do you see between that time period and what we’re seeing right now?

Michael Green 17:35
Well, just like the 1990s, and today, we’re seeing a market that is narrowing, it is focusing itself on the companies where we have adopted a narrative that says, These are almost the story of stocks, right, the nifty 50 from the 1970s. The just don’t sell us JDS unit phases, or Cisco’s, which were the, you know, selling the picks and shovels to cycle, we’re seeing the same thing happened now where I would argue the mag seven is the Magnificent Seven is beginning to narrow into the magnificent four that ultimately will end up being something less than that. But that narrowing itself is indicative of money that is flowing in and increasingly just trying to find some reason to be invested.

James Connor 18:21
Yeah, and I guess one other similarity, too, is, when I look at a lot of these stocks, like Nvidia, for example, it looks like it wants to go to 1000 bucks, it just wants to like it’s being pulled there. Right. And we saw a lot of that back in the late 90s and early 2000s.

Michael Green 18:37
Yeah, I mean, I have no idea whether that pull us to 1000 bucks or 2000 bucks. You know, and I want to emphasize that I think these forces can maintain themselves for a very long period of time in the scheme of things right. And very long can be months, it can mean years. But I do think it’s actually really critical for people to understand that a large portion of the buying that’s happening in markets does not actually involve thoughtful application of analysis on fundamentals, or anything else.

James Connor 19:06
So you made mention earlier that you don’t think the US economy is as strong as we’re led to believe it is, but yet the s&p and the Nasdaq continue to go higher, as if everything’s okay. What What’s your view here on these markets? Are they going to keep going up into year end? Or are we going to see a correction at some point? Well, I think if so, what’s going to be the catalyst? Well,

Michael Green 19:26
I think ultimately, it boils down to that strength of the US economy. We both you know, most people are aware of this at this stage that they understand that when they get a job, they’re automatically opted into a 401 K, that money is then allocated typically passively into these strategies, as long as that flow of funds, supports buying activity that pushes prices higher. None of the fundamentals actually really matter. It’s when those layoffs actually begin to mount it’s when that narrative begins to change. It’s when those flows begin to move in the The opposite direction, that you’ll see markets correct. And whether that’s going to happen in the next month, or whether that’s going to happen in six months, I can’t possibly tell you what I do know is as prices move higher, it becomes easier to withdraw large sums of money than it becomes to contribute large sums of money. withdrawals are always a function of asset levels. Contributions are always a function of income levels. And so when asset levels rise far more rapidly than incomes do, you can create a mismatch that then forces a correction.

James Connor 20:33
And I think the other risk that I kind of see, I want to get your thoughts on this, but it’s the price of oil right now. It’s hanging around 75 bucks a barrel. But there’s a lot happening in the world. So that can change overnight. But if we if we see oil going to 100 bucks, I mean, that’s it. People aren’t going to be taking their summer trips over to Europe or jumping in the car and driving across the country. What are your thoughts on energy?

Michael Green 20:55
Well, I think it’s I think it’s critical for people to understand that we’re actually you know, as much as we’re worried about oil prices going to 100 bucks. The reason it matters now, is because people’s budgets are so stress stressed, right? It’s a combination of the fact that they have less disposable income because other prices have risen. Right. So while I’m not particularly worried about continued inflation, one of the reasons why I’m not that concerned about it is because I understand that household budgets are so stretched, that they simply can’t afford to pay that next dollar. And so if we actually look at a situation like oil prices going higher, unfortunately, that means that you’re likely to see people forced to spend less elsewhere, you implicitly or explicitly said that when you said people stopped taking vacations, people stopped traveling. We’re already seeing that right. One of the companies that just announced layoffs was Expedia which fired 15% of its labor, its labor force, in an environment on ostensibly a very strong economy. That’s really not something you would expect to see, right. That type of travel, that type of growth is consistent with a strong employment market, everybody should be traveling. But the simple reality is, is they’re not because they can really no longer afford to do so.

James Connor 22:09
I want to move on now and discuss the financial situation in the US this time that last year, we had the regional banking crisis. And we saw the collapse of Silicon Valley Bank and also Signature Bank first republic got acquired by JP Morgan, Credit Suisse was acquired by UBS. Here we are a year later. Now we have this New York Community Bank coming up, and I’ve never even heard of this bank up until a couple of weeks ago. But a big part of their issues has to do with the fact that they acquired a loan portfolio from Signature Bank of $13 billion dollars, and now they’re having trouble with this. What are your thoughts on this? And is this Is there going to be more to come?

Michael Green 22:49
Well, I mean, what pulled down New York Community Bancorp was really the commercial real estate exposure. In particular, a couple of multifamily properties that they had picked up, the performance was far worse. We are seeing commercial real estate suffer, we are seeing that get worse. I think it’s important for people to understand that the high level of interest rates is not so much a problem for everybody at every point in time because many companies and many individuals have termed out their debt. If you have a fixed rate 30 year mortgage, you’ve turned out your debt, there’s nothing that is affecting you from a change in interest rate policy. Ironically, if you have a 30 year mortgage, with a fixed rate debt, and you have money in a money market account, you’re actually benefiting from an increase in interest rates. The problem is, is that not everybody benefits from it. And those individuals become more and more stressed and approach the breaking point, we’re seeing that within commercial real estate, we’re beginning to see that within multifamily residential, we’re clearly seeing it in the rising default rates. For many individuals in things like young people with auto loans where they went out and paid top price for those vehicles. Now, they’re suddenly recognizing that they just don’t have the funds. To pay those off. We’re seeing incredible increases in delinquency rates for young people on auto loans, credit cards, etc. When people hit the breaking point, their spending patterns change radically. Right, the day before bankruptcy, you probably still go buy that cup of coffee. And in fact, you probably get an avocado toast because you know, you’re about to file bankruptcy. And this is gonna be the last avocado toast you can buy on a credit card. The day after bankruptcy, you can’t spend on any of that stuff. You can’t qualify to get your own apartment, you can’t qualify for a mortgage, you can’t qualify for an auto loan. And so your pattern of behavior changes radically. That’s why a debt crisis is such an important event because it causes a radical shift in people’s spending behaviors. Right? We saw that with the failure of Lehman Brothers in 2008. Many of the factors that we talked about today, the fact that unemployment remained relatively low versus prior recessions, the fact that economic indicators seemed to be strengthening throughout 2008. In fact, economic surprise indices hit their local highs in September of 2008. Basically, everyone’s saying something along the lines of it’s not nearly as bad as we thought it was, until the event of Lehman Brothers suddenly called into question, do you actually have the cash that you’re supposed to have? We addressed that last year with the failure of Silicon Valley Bank and other banks, by dramatically expanding FDIC protections by effectively creating conditions with the BTF P that provided liquidity to the banking system. Now we’re changing those systems again. And if we were to see something like an increase in oil prices, as you alluded to earlier, just that tiny incremental stress can very much become the straw that breaks the camel’s back.

James Connor 25:53
So I guess my question to you is, do you think there’s more New York community banks out there?

Michael Green 25:57
I do think there are because the commercial real estate space, while it’s small relative to the total assets of the banking system is not small as it relates to the regional banking system. So the regional banking system is far more stress and has far higher exposure. Of course, the key difference that people need to be aware of in 2008 was the failure of Lehman Brothers. I apologize. You were looking at a you’re looking at a failure of a money center bank, effectively, those in financial markets, who had their deposits or access to credit through Lehman Brothers suddenly found themselves unable to spend for financial assets. If New York Community Bancorp fails, and the FDIC protects all deposits, it’s a little bit like the tree falling in the forest, right? Did it really matter to you as an individual, it doesn’t change your individual spending patterns. But it does set in motion a liquid, you know, a liquidation of commercial real estate, that then leads to the destruction of capital, because those looking to refinance their commercial real estate, suddenly have to show up with cash to deal with a much lower valuations or appraisals that you might see. That’s one of the mechanisms by which you actually shrink liquidity is when values fall and you look to refinance, you have to show up with cash, and that cash just disappears from the economy.

James Connor 27:23
So far, our discussion has been focused on the US. But when you look at Europe, and you look at Asia, do you see any concerns there?

Michael Green 27:32
Well, I think everything we said about the United States is unfortunately magnified. If we look internationally, we’re ironically seeing behaviors in China, that feel very consistent with the price behavior that we’re seeing in their financial markets. That’s a large part because we’re seeing a lot of divestment from China. But perversely, even as Japan and Germany are entering recession, their stock markets are at all time highs. And that’s because we’re plowing proceeds into those markets, chasing the performance. So even as their underlying economies deteriorate, and they face increasing domestic stress. Germany, for example, is very actively seeing protests and demonstrations. That’s actually unfortunately, the same type of phenomenon that we’re talking about here where the money that is going into Germany, or into Japan is increasingly going in through things like futures, or index investing. That is simply reinforcing momentum characteristics and markets that didn’t exist before.

James Connor 28:33
So just to summarize everything we talked about, we you’re concerned about the US economy, you see a slowing economy, and you’re also concerned about the debt levels, and also maybe the real estate and commercial real estate. sectors. You’re also concerned about Europe, you’re concerned about potential liabilities in China. What does all this mean? And how is an investor? How do we manage all of this?

Michael Green 29:02
Well, I think it’s I think the important point that I would raise is, as an investor, you should always be concerned about all these things, right? You can turn around and you can say, does that make them an investable? And I think in many situations, the answer that has to be No, right? You always have to find places to put your money to work. I think one of the important components that I’m highlighting though is is that if we’re actually receiving false signals, from things like stock prices, from things like credit spreads, ultimately, that’s telling us that the investment opportunities that are in front of us in those areas are much riskier and likely to return far less than we would anticipate. The way to resolve that is simply to go into investments that are currently largely out of favor that people are suggesting, offer unattractive returns. Understand that really what’s happening is is we’re applying a narrative to it. Right, the US interest rates the fact that we’re now at 4.7% On us tenure interest rates, that we’re seeing mortgage rates hit, remove, you know, move back above 7% and to highs, and we’re seeing that negatively impact both existing sales and new home sales. That’s telling you that these are unsustainable levels of interest rates. Right steal from herb Stein, if something is unsustainable, that means it can’t go on forever? The answer is we’re going to ultimately have to cut interest rates. And that would suggest that fixed income is a far more interesting place to be than equity markets, for example, or real estate.

James Connor 30:31
Like we started this discussion with your views on passive versus active management. And I want to end here, but maybe we can just you can tell us what percent of all trading is passive versus active in? Also, what is the annual growth rate?

Michael Green 30:49
Yeah, so So I think those are important components. One is when we talk about passive recognize what we’re really describing are not passive investors. But algorithmic investors that operate off of very simple models. What you know, what should you buy, you should buy equities in proportion to their market cap, you should buy bonds in proportion to their market cap rate, the quantity of bonds that have been issued. Those are very simple rules. When should you buy you should buy anytime anyone gives you any money? Should you? Is there any situation under which if they give you money, and you should not buy? No? Absolutely not? Right, you have to invest that money. So when you recognize that they are not actually passive investments, but instead algorithmic systematic investments, that simply reflects people having jobs and having pre made allocations to make investments, then you can understand that these strategies can cause markets to veer off of fundamentals dramatically. When you Secondly, ask the question, what fraction of trading activity or volume is tied to passive investing? That’s actually a little bit trickier than you would think? Because the answer is, you know, one, the flows that go in if I choose to put money into my Vanguard target date fund, that’s a single flow that goes in and so it doesn’t represent a ton of trading activity. But actually, a remarkable amount of trading activity is happening behind the scenes to facilitate your index investment. Typically, that money going to a target date fund will do something like allocate initially into futures. In order to create the futures there has to be index arbitrage futures, arbitrage traders, who are willing to recreate those futures with the single names. That is trading that is not technically passive. But it’s tied to passive dynamics. Within ETFs. Anytime you buy an ETF, you have to go through the creation redemption process, that trading activity is technically not passive, but very much tied to that process. And again, has nothing to do with fundamentals. The shocking statistic that I try to share with people on a regular basis is according to a JP Morgan analysis all the way back in 2017, less than 10% of trading had a fundamental component to it. Today, that number is significantly lower. And that is a radical change from the the behavior that we had prior to the global financial crisis. Prior to the global financial crisis between 60 and 70%, of all trading activity involves somebody who had done fundamental work around the behavior of the individual company. Now that number is significantly less than 10% of all trading activity involves any work that’s tied to fundamentals.

James Connor 33:35
No, that’s a that’s a very interesting comment, because I could have my retirement funds tied up in an ETF which is invested heavily into Nvidia. Right, and nobody’s done any work on it.

Michael Green 33:48
Well, I think unfortunately, that is a byproduct of the cycle that we’ve gone through. I mean, remember how our retirement system in the United States is developed. It used to be that a company would provide a pension plan for you, we discovered that those professional investors running pension plans were incapable of managing the assets to deliver the the desired levels of retirements, we got rid of the defined benefit plan and replaced it with a defined contribution plan. You as an individual were expected to be able to manage your assets to deliver returns that couldn’t be done by the companies. That in turn then led people to say, well, I don’t know what I’m doing. So I’m just gonna buy everything in the market. Right? Now everybody is actually presuming that somebody else is doing the work. This is very much like the internet phenomenon in web 2.0. Where if you’re not paying for the product, right, you’re not paying for manager, you’re not paying for an asset allocator you’re effectively just using historical data that is available to everybody to build a program that would have worked in the past. If you’re not paying for that service. In Internet words, we you know, internet descriptions, we If you’re not paying for it, you’re the product. And that’s really unfortunately, what’s developed is that the American retiree, the American worker, the American saver has become the product rather than a thoughtful process of capital allocation.

James Connor 35:15
So are active portfolio managers like Warren Buffett, are they a dying breed? If you and I are talking and five years from now, is it going to be 100% passive

Michael Green 35:25
It’s not going to be 100% passive, because ultimately, I think that the system is self correcting. Unfortunately, it’s self correcting in a likely violent fashion. I’ve shared my work around the passive dynamics and how it’s influencing markets, with individuals at the Federal Reserve, the IMF, the Bank of International Settlements, etc. None of them are able to refute the analysis, the passive is changing the behavior of markets, and that ultimately, it likely ends with a violent reversal. Their reaction to that is we can’t actually disagree with your numbers, we think you’re probably right. When I said, Well, that’s fantastic. What can we do about it? Their answer is there’s nothing we can do. Because unfortunately, the regulatory environment is influenced by the lobbying activities of the vanguards and black rocks of the world, they largely control the narrative, people have accepted the idea that the right way to invest is to invest passively. And we’re now in a situation where something like 85% of all investors are placed, you know, through their employment into something like a target date fund, and never change that. They just never change that. No, there’s something to be admired about that discipline. But let’s be honest, it’s not really discipline, it’s inattention.

James Connor 36:43
And when you say a violent reversal, are you referring to something like 1987?

Michael Green 36:48
Well, I would actually say that 1987 was exactly this type of dynamic, it was actually caused by an imbalance in orders to sell s&p futures versus buy s&p futures. If you were to see something like that happen today, it would manifest itself similarly. But the challenge that you now have is, is that the conditions are in place in which the next dollars in are likely to be less than people think they are. Right? We’re looking at a situation where basically everybody is into the pool, everybody is participating in the stock market. And now we’re suddenly facing the retirements of the baby boomers, which means that the net flows actually threatened to turn negative. That imbalance is what shows up as a market crash. Whether we recover from it is a totally separate question.

James Connor 37:38
Mike, as we wrap up, what should investors be paying attention to in the coming months?

Michael Green 37:43
Well, I think, you know, one of the things I would just encourage people is to educate themselves in terms of the changing understanding of the influence of passive investing, and how the markets can actually materially mislead you as to the strength of the economy. I think that’s actually a really important thing for people to do more research on. There’s tons of academic papers that, unfortunately, are well beyond the, you know, mathematical capability of most individuals. But that doesn’t mean you shouldn’t actually try to understand what’s going on. I encourage people to educate themselves on this. The second component is to understand that our policymakers are increasingly relying on these financial markets that are increasingly disassociated from the actual fundamentals. So it feels like many of us feel like we’re going crazy, like we’re actually watching markets that seem disconnected from the fundamentals that we’re experiencing in our daily lives. You’re not crazy, this is actually happening. And the question is, what do you do about it? And how do you respond to it, and I would encourage people to, you know, consider at least taking actions to preserve the safety of their investments, as compared to following around along with the crowd at this point.

James Connor 38:56
Very interesting points. And, Mike, I want to thank you very much for spending time with us today. And I look forward to our next discussion, and I hope you get home safely.

Michael Green 39:05
Thank you very much. I look forward to it as well. I look forward to arriving home safely.

James Connor 39:09
Well, I hope you enjoyed that discussion with Mike Green and you have a good understanding of the difference between passive investing versus active investing. And if you need help in understanding these concepts, or if you need some help in preparing for your financial future, consider having a discussion with a Wealthion endorsed financial advisor on There’s no obligation to work with any of these advisors is a free service that Wealthion offers to anyone who has an interest. Don’t forget to subscribe to our channel, and also hit that notification button to be kept up to date on future events. We’d have some amazing content coming out here in the coming weeks. Once again, thank you for spending time with us today and I look forward to seeing you again soon.

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